RBA eases, ultra-dovish statement suggests more to come

This afternoon the Reserve Bank of Australia cut the official cash rate by 0.25% to 2.25%, an all-time record low.

In a clear sign that further rate reductions are likely the monetary policy statement was incredibly dovish, even considering that rates were cut, with only a few positive comments found within the entire document. The full document can be viewed below. The phrases that I believe are of significance are in bold.

February 2015 Policy Statement

“At its meeting today, the Board decided to lower the cash rate by 25 basis points to 2.25 per cent, effective 4 February 2015.

Growth in the global economy continued at a moderate pace in 2014. China’s growth was in line with policymakers’ objectives. The US economy continued to strengthen, but the euro area and Japanese economies were both weaker than expected. Forecasts for global growth in 2015 envisage continued moderate growth.

Commodity prices have continued to decline, in some cases sharply. The price of oil in particular has fallen significantly over the past few months. These trends appear to reflect a combination of lower growth in demand and, more importantly, significant increases in supply. The much lower levels of energy prices will act to strengthen global output and temporarily to lower CPI inflation rates.

Financial conditions are very accommodative globally, with long-term borrowing rates for several major sovereigns reaching new all-time lows over recent months. Some risk spreads have widened a little but overall financing costs for creditworthy borrowers remain remarkably low.

In Australia the available information suggests that growth is continuing at a below-trend pace, with domestic demand growth overall quite weak. As a result, the unemployment rate has gradually moved higher over the past year. The fall in energy prices can be expected to offer significant support to consumer spending, but at the same time the decline in the terms of trade is reducing income growth. Overall, the Bank’s assessment is that output growth will probably remain a little below trend for somewhat longer, and the rate of unemployment peak a little higher, than earlier expected. The economy is likely to be operating with a degree of spare capacity for some time yet.

The CPI recorded the lowest increase for several years in 2014. This was affected by the sharp decline in oil prices at the end of the year and the removal of the price on carbon. Measures of underlying inflation also declined a little, to around 2¼ per cent over the year. With growth in labour costs subdued, it appears likely that inflation will remain consistent with the target over the next one to two years, even with a lower exchange rate.

Credit growth picked up to moderate rates in 2014, with stronger growth in lending to investors in housing assets. Dwelling prices have continued to rise strongly in Sydney, though trends have been more varied in a number of other cities over recent months. The Bank is working with other regulators to assess and contain economic risks that may arise from the housing market.

The Australian dollar has declined noticeably against a rising US dollar over recent months, though less so against a basket of currencies. It remains above most estimates of its fundamental value, particularly given the significant declines in key commodity prices. A lower exchange rate is likely to be needed to achieve balanced growth in the economy.

For the past year and a half, the cash rate has been stable, as the Board has taken time to assess the effects of the substantial easing in policy that had already been put in place and monitored developments in Australia and abroad. At today’s meeting, taking into account the flow of recent information and updated forecasts, the Board judged that, on balance, a further reduction in the cash rate was appropriate. This action is expected to add some further support to demand, so as to foster sustainable growth and inflation outcomes consistent with the target”.

So what to make of it? What does it mean for policy moving forward? While there was no specific easing bias was found in the final paragraph, merely that the ‘action is expected to add some further support to demand, so as to foster sustainable growth and inflation outcomes consistent with the target’, it’s clear that through by downgrading their expectations for GDP growth and unemployment that they are positioning for additional cuts ahead. This is further buttressed by the view the Australian Dollar remains above most estimates of its fundamental value and, while its recent fall will likely contribute to an increase in tradable inflation, subdued labour costs, along with below-trend economic growth, will keep inflation within target over the 1-2 years ahead. Sound like conditions that warrant a mere one-off rate cut? No. History suggests it won’t be.

While the above focuses solely on their traditional areas of monetary policy it was very interesting to see them add the line that they are ‘working with other regulators to assess and contain economic risks that may arise from the housing market’. While there’s been plenty of discussion in recent years above the need for macroprudential tools for housing, both negative and positive, it is clear, to me at least, that policy changes are in the pipeline. The RBA understand that there are risks in stoking property prices, particularly in capital cities across the Eastern seaboard, by reducing interest rates further. Just have a look at the performance of property markets since they last cut in August 2013. If they indeed want to push the value of the Australian Dollar lower, particularly should the US Federal Reserve not begin to tighten policy midway through the year, they will to have to a) lower interest rates and b) have secondary measures in place to prevent rapid house price appreciation. Some may disagree but, in my opinion, more stringent policies are on the way.

So what will we see from here? First and foremost we’ll see downgrades to forecasts for GDP, CPI and unemployment in the RBA’s statement on monetary policy on Friday. With a softer outlook for all three it’s highly likely that there’s at least one rate cut, perhaps more, to come over the course of 2015. I’ll reserve my call for the March policy meeting closer to the date but, at 55%, the market pricing for a 25bps cut looks about right.